Overview
In accordance with Rule 206(4)-7(b) under the Advisers Act, an investment adviser is required to perform an annual review of its compliance policies and procedures to determine whether they are adequate, current and effective in view of the advisory firm’s businesses, advisory services, and regulatory requirements.
In this review, the Chief Compliance Officer (or other designated individual(s)) is required to consider (i) any compliance matters that arose during the previous year; (ii) any changes in the advisory activities of the advisory firm; (iii) any previous SEC and other applicable regulatory examination deficiency letters (to confirm that past deficiencies were corrected and are not reoccurring); and (iv) any changes in the Advisers Act and other applicable laws and regulations that might suggest the need to revise certain policies and procedures.
Goals of the Annual Review
Determine whether the Procedures are Adequate
1. Do the procedures address all applicable areas of the advisory firm’s business?
2. Have all laws and rules been cited?
3. Do the procedures require the advisory firm to do what the rules require?
Determine how Effectively the Advisory Firm’s Procedures have been Implemented
1. Are they reasonably designed to detect violations and promptly correct any violations that have occurred?
2. Is there sufficient: (i) supervision; (ii) employee training; (iii) forensic testing; and (iv) problem detection and correction?
Methodology for Conducting the Annual Review
Step 1: Review the inventory of the compliance obligations under state and federal laws, SEC rules, contracts with clients, offering documents and disclosures made to clients. Review should include:
* Identification of recent SEC exams including any deficiencies raised and any corrective actions taken;
* Identification of the advisory firm’s interim reviews and other audits and any follow-up or corrective action;
* Identification of any serious compliance issues that arose at the advisory firm in the past year;
* Identification of any serious compliance issues that arose in the investment advisory industry in the past year;
* Identification of violations reported pursuant to the advisory firm’s code of ethics;
* Analysis of compliance implications of any new businesses, discontinued businesses and change in the advisory firm’s operations during the past year;
* Analysis of new statutory or regulatory requirements that impact the advisory firm’s business;
* Identification of “hot topics” identified by the SEC staff;
* Description of how the advisory firm sought to identify risk; and
* Description of how the advisory firm went about assessing the effectiveness of critical controls.
Step 2: Compare the inventory of obligations against existing procedures:
* Determine whether the procedures specify the actions to be taken to achieve compliance;
* Identify any gaps and determine whether new procedures need to be developed or current procedures enhanced to address such gaps; and
* Determine whether new obligations arose as a result of new products offered or new regulations were adopted since the last review.
Step 3: Assess the effectiveness of existing procedures and how well the advisory firm is implementing the procedures as currently written. For each procedure evaluate whether the procedure:
* Makes violations less likely;
* Results in prompt identification of violations;
* Collects in a timely fashion the information necessary to allow the advisory firm to correct problems as they are identified;
* Is written in plain English articulating the goal of compliance and how it is supervised; and
* Is adequately supervised by responsible personnel of the advisory firm.
Step 4: Engage in a risk-assessment strategy that targets high-risk areas of the advisory firm’s business.
* Review well-recognized areas of conflicts of interest present in the advisory firm’s operations (i.e. personal trading accounts, allocation of aggregated orders and advertising materials);
* Identify any conflicts that, if left unmitigated, could result in harm to the advisory firm’s clients; and
* Develop procedures to mitigate or eliminate these conflicts.
Step 5: Test and assess the procedures periodically.
* Use “forensic testing” including the examination of samples of accounts, transactions, communications for consistency with the advisory firm’s procedures, compliance with the law and outcomes for clients.
Documentation of Findings
As part of the annual review, the advisory firm should document the following:
* Whether the compliance policies and procedures continue to be reasonably designed to prevent and detect violations of the Advisers Act and its rules;
* Whether the compliance policies and procedures are being adequately carried out by accountable personnel of the advisory firm; and
* Whether any customer harm resulted from any significant compliance deficiency that was uncovered as part of the annual review.
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